Investors looking to apply the proposed EU climate benchmark in their strategies received good news from S&P Dow Jones Indices on Wednesday when it revealed a slight outperformance of its index concept over one year.
In a mock portfolio, the S&P Eurozone Paris-Aligned Climate Index Concept (Pac Concept) performed 22.4%, while the S&P Eurozone Largemidcap returned 21.5%, as of 1 January.
S&P commented that the concept outlines “how climate-related objectives can be met, due to the use of optimisation, while maintaining similar performance to the underlying index, with low tracking error”.
“This results in a broad, diversified index that should perform similarly to the underlying index.
“Factor analysis shows there to be unexplained alpha that may be driven by the climate strategy of the Pac Concept,” S&P added.
Over the period studied, starting from 30 December 2016 to 01 January 2020, the strategy had a 1% tracking error.
In order to limit global warming to 1.5°C, the EU Technical Expert Group (Teg) released a final report in 2019, in which it proposes two climate benchmarks.
S&P Dow Jones Indices has defined a benchmark concept according to the EU’s proposed requirements, which are still to be finalised.
Public companies account for around 47% of global carbon emissions, S&P said, which makes low-carbon indices an opportunity to increase investments in low-carbon companies.
“This new breed of sustainable climate indices will not only offer solutions that intend to be impactful, but equally aim to provide investors with reduced risks from transitioning to a low-carbon economy and the consequences of physical, environmental events while capturing financial opportunities that arise,” S&P commented.
The Pac Concept applies to the eurozone region and goes beyond the requirements of the EU’s proposed Paris-aligned Benchmark by incorporating additional climate-related factors.
As set out by the Task Force on Climate-related Disclosures (TCFD), the concept addresses transition risk, physical risk and opportunities linked to climate change.
Despite reducing the transition risks of climate change, the Pac Concept shows a similar risk/return profile in the back-test as the underlying benchmark.
- A version of this story first appeared on ESG Clarity’s sister site Expert Investor.